Everyone dreams of a secure retirement.
Unfortunately, most people don’t have sufficient financial resources to maintain a comfortable standard of living until the day they die.
In fact, a poll conducted by Allianz showed that 61% of baby boomers fear outliving their money more than death itself!
And for good reason…
With average life expectancies steadily increasing, many seniors face retirements of 20 years or longer. This is a positive trend if you want to see your grandchildren grow up, but one that also increases the risk of outliving assets.
In financial jargon, it’s called longevity risk.
More and more retirees will have to rely solely on the Social Security system, which is already overburdened.
But there is some good news for those who fear outliving their money and have the bulk of their net worth tied up in retirement accounts…
Longevity Insurance to the Rescue
The Treasury Department recently approved the use of longevity annuities in qualified retirement plans.
With a simple annuity (known as a single-premium immediate annuity), you pay an upfront sum of cash to an insurance company in exchange for guaranteed lifetime payments.
In effect, this makes it impossible for retirees to outlive their money.
A longevity annuity is a special type of annuity. Instead of the payments starting immediately, they begin at an advanced age – typically 80 or 85 years old.
The size of future payments depends on three variables: the amount invested, the buyer’s age at the time of purchase, and the buyer’s life expectancy when the payouts start.
Let’s look at an example…
A 50-year-old man buys a longevity annuity for $50,000. By deferring annuity payments to age 85, he will receive a higher payout than with a simple annuity that begins now.
This results in annual payments of more than $40,000 (in current dollars) from age 85 until death. A woman would receive slightly less due to a longer life expectancy.
Sounds like a sweet deal. But in order to truly provide us with peace of mind, the annuity payments have to be safe. Thankfully, every state in the United States has an insurance guarantee association protecting consumers against insurer bankruptcies – meaning the investor faces no risk of an insolvent insurer.
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Now, there are two important provisions to customize the contract – for additional premiums, of course.
Inflation and Early Death Protection
The first stipulation helps to protect the account from inflation, and ensures that the beneficiary will always be paid in real dollars as opposed to current dollars.
This inflation rider is a “must-have” – especially when deferring payments for more than 20 years. We all know that policymakers are trying to encourage inflation.
Another popular option is the return-of-premium provision. The most obvious downside of longevity annuities is the potential for death before any of the payouts start. This means that you would have forked over all of that hard-earned money for nothing.
To guard against this risk, there is a provision ensuring that 100% of the premiums will be returned to your heirs should death occur before any payouts are made.
Again, enabling both provisions is going to eat into your future payouts. You’ll want the inflation protection, but not necessarily the return of premium. After all, the whole point of this insurance is to hedge against the risk of us living too long, not dying young.
And remember, once you enter into an annuity contract, it is irrevocable. The money is locked in with no access to the investor – even in an emergency.
Is a Longevity Annuity Right for You?
While these contracts can benefit many investors, they’re not right for everyone.
Those with significant assets would be better off sticking with a diversified portfolio of dividend stocks and bonds.
And longevity annuities don’t make sense for those with life-threatening illnesses.
But for retirees at risk of depleting retirement funds or those with a family history of long lives, they make perfect sense.
By annuitizing a small portion of your portfolio (10% to 15%) with longevity insurance, you can rest easy knowing you’ll never outlive your money.
Safe (and high-yield) investing,
Richard Robinson, Ph.D.